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About Tim

Since 2000, he has been working with IGM to develop a range of Chinese language products for mainland China and Hong Kong. In his current role, he’s responsible for all the China content including IGM's Chinese language services. He provides key insight on the CNH/CNY markets as well as flow commentary on the emerging Asian FX market and Asian credit.

Tim joined us in Hong Kong in 1995 from MMS International. Before that he worked in the banking sector.

Tim has a bachelor’s degree in economics from Wolverhampton University.

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by Tim

The NPC meeting officially kicked off in Beijing (22 May). There, Premier Li Keqiang announced:
- a CNY1,000bn issuance of central government special bonds (CGSB), versus the market consensus of CNY2,000bn
- a CNY3,750bn issuance of local government special bonds, versus last year's CNY2,150bn and a market consensus of CNY3,500-4,000bn
- a rise in fiscal deficit-to-GDP ratio target to 3.6%, vs last year's 2.8%.

Beijing announced that the National People's Congress (NPC) will commence its annual meeting on 22 May, after being postponed from 5 March due to the COVID-19 outbreak. Nobody is sure if the year 2020 GDP growth target will be announced there given the deep downturn in Q1. If a target is given, we guess it is going to be at an achievable level, say 3% or slightly lower. No matter whether a growth target will be given, we will definitely see a bigger fiscal budget deficit number and higher CPI target in the annual Government Work Report (GWR) announced at the NPC.
We expect a significant increase in the headline fiscal budget deficit to 4.5% or even 5.0% of GDP in 2020, from the budgeted 2.8% in 2019, given a declining fiscal revenue and an expanding expenditure. Meanwhile, a quota of special local government bond issuance at CNY3.5tn (not surprising if’s as high as CNY4tn) will be given. Moreover, the CPI inflation target will likely be raised to 3.5%.
In regard to local government bond issuance, we expect to see a huge supply of local government bonds in May after an issuance of CNY1000bn local government special bonds (i.e. the third batch of local government special bonds for 2020) was announced.
In April this year, we saw a seasonal decline in local government bond supply, which will be followed by an increase in May and June (chart 1). Repeating its pattern in previous years, supply will remain abundant in Q3, we believe.

The Politburo Meeting on 27 March hinted at a big stimulus package ahead. The meeting stated that macro policy loosening should be stepped up to boost domestic demand and achieve the "Six Stabilities" (stable employment, trade, financial markets, investment, foreign capital, and expectations). Specifically, the central government will issue a batch of special government bonds (SGB), and the local government special bond (LGB) quota will also be enlarged. In addition, the meeting called for accelerated issuance and use of local government special bonds, speeding up the preparation and construction of large and important infrastructure projects and better implementing the reduction of taxes and administration fees.
We expect the government to raise the budgetary deficit to 3.5% of GDP from the previously 3.0% and lift the tax and administration fee target to CNY2.5tn from CNY2tn realized last year. Regarding off-budget items, we expect special local government bond issuance to rise to CNY3.5tn from CNY2.15tn in 2019. Meanwhile, the statement of the PBOC 1Q meeting on the same day also put a great priority on assisting a firm recovery of the real economy and pledged to increase support to SMEs and the private sector. PBOC wants to see the loan prime rate (LPR) play a more important role in lowering real funding costs.

As Emerging Markets go into recession, EM policymakers have rapidly deployed a broad range of support measures with more to come, but it remains to be seen how effective these will be in mitigating the EM growth hit. As far as China is concerned, negative GDP growth in Q1 looks unavoidable. The most pessimistic estimate in the street is -9%. For the full-year GDP growth, the revised estimates in the street fall between +1% and +4%. In light of the gloomy economic outlook, Beijing definitely will step up stimulus. Now a cut in the benchmark deposit rate is on the cards, which could be a more meaningful means to boost retail consumption.
With interest rates trending downward, onshore government bonds and policy bank bonds have kept rallying recently on the back of strong buy-and-hold demand (chart 1). The latest data suggests the China bond market saw USD11bn of net inflows from foreign investors in February, up from only USD2bn in January (chart 2). Among the paper which is already or being included in the major global government bond indices, policy bank bonds (PBBs) registered a bigger increase in foreign investors' portfolios than China Government Bonds (CGBs). Of the USD11bn of net inflows in February, USD5bn was taken by PBBs, USD4bn by CGBs with the remainder by negotiable certificates of deposit (NCDs) and medium-term notes (MTNs).

It is still too early to say whether the COVID-19 outbreak will be effectively contained by the end of Q1. However, it’s quite certain that Chinese property developers will not see a significant recovery in sales over the rest of this quarter.
In the USD bond market, Chinese IG property names saw credit spread tightening after PBOC made a huge liquidity injection and lowered reverse repo rates as soon as the extended LNY holiday was over. As far as Chinese HY property names are concerned, we saw their short-dated papers well absorbed by the market as soon as they were launched in the primary market. All these seems to suggest the developers' balance sheets are barely impacted by the sharp decline of sales. However, if we look at their refinancing schedule more closely, we may doubt such a resilience will be sustained.

With the coronavirus outbreak still evolving, the market signal is clear: less growth and more accommodative policy in China.
Further to our forecast given in the previous issue of China Insight that "China will only achieve 4.8-5.3% GDP growth in 2020" because of the disaster, we in the current issue present our view on how the yield curves in China are being impacted.
The broadening of the coronavirus outbreak in China, the lockdown of Hubei province and the extension of LNY holiday have already given a hard hit to the manufacturing sector. Due to that, we inevitably will see a fall in PMI indices in Feb and March. At worst, PMI will continue to be under downward pressure over the rest of H1. In our view, some downturn of the manufacturing sector as a result of the disaster is already priced in 5yr IRS, but a drop by 2 to 3 points in PMI from here should still be able to drive IRS much lower to sub-2016 lows. Given the strong correlation between the NBS Manufacturing PMI and 5yr CNY IRS in the past (chart 1), 5yr IRS at 2.55-2.60% appears to have priced a fall in Feb PMI to around 49.0 from January's 50.0. A further decline in PMI to the 48.0 region in March or during the March-April period, in our view, will bring 5yr IRS down further to 2.35-2.45%.

Chinese onshore bonds saw a reduction of net inflows to USD2bn in October, down 82% from a month ago (chart 1). Foreign investors' net purchase of CGBs slowed to USD2.2bn, down 70% from September. Meanwhile, policy bank notes and NCDs saw small outflows of -USD0.5bn and -USD0.8bn respectively, vs an inflow of USD2bn to each of them in September. We attributed the slowdown in bond inflows largely to bear-steepening of the CGB yield curve as a result of the growing reluctance of PBOC to ease monetary policy in an environment of rising CPI inflation.

The health of China's smaller banks has come under pressure as Yichuan Rural Commercial Bank and Yingkou Coastal bank are said to have suffered bank runs in recent weeks amid fears over poor management and liquidity issues. Earlier this year, a rare government takeover of Baoshang Bank and a state rescue of Jinzhou Bank and Hengfeng Bank raised concerns about the underlying health of hundreds of small banks in China.
Admittedly, China has entered another round of re-leveraging, albeit a softer one this time. With the fundamental issue of macro leverage unsolved, we expect China's debt-to-GDP ratio, currently in the 290-300% area, to reach 320% by 2025 (chart 1).

PBOC cut the 1-year mid-term lending facility (MLF) rate by 5bp to 3.25% on 5 November (chart 1) while rolling over the matured MLF refinancing. The cut will likely drive down the loan prime rate (LPR) further, which was left unchanged at 4.20% and will be repriced on 20 November (chart 2). As the first cut in the MLF rate in this easing cycle, it suggests PBOC is faced with growing risk of further economic slowdown. However, the magnitude of the cut is small, reflecting the degree of monetary easing is constrained by growing CPI inflation.

Given the lower-than-budgeted fiscal revenue growth so far in 2019 (chart 1), the central government may find it difficult to fulfil its fiscal transfer budgets. As such, local governments could rely more on borrowing to support infrastructure investment. As the total local government bond issuance quota of CNY3.1tn has been fulfilled this year, the total size of extra issuance could be up to CNY2.5tn (including CNY1.3tn in general and CNY1.2tn in special) if necessary. If the government decides to fully utilize the extra special bond issuance quota within the debt ceiling, it could bring CNY2.1tn funds to the government to support infrastructure investment. However, chart 2 shows that special bond issuance has been subdued since it reached its year-high in June. Given the restricted commencement of winter construction, special bond issuance will likely remain subdued in Q4.

A couple of negative headlines came out on 8 October before the 13th round of US-China trade talks starts.
The US blacklisted 28 Chinese entities and government agencies over human rights violations and repression in Xinjiang;
White House has started looking to consider limits on the US pension investments in Chinese equities;

PBOC on 6 September announced a cut in the reserve requirement ratio (RRR) for all financial institutions by 50bps and a cut for some city commercial banks by an additional 100bps, effective on 16 September.
As per PBOC, the RRR cut will release liquidity to the amount of CNY900bn (chart 1). The PBOC stressed that the 900 billion yuan of liquidity should enhance the source of funds for financial institutions to support financing needs of the real economy.

The HKMA, on 26 August, announced it had completed a review of its framework for the provision of liquidity to Authorised Institutions (AIs). A new Resolution Facility was introduced to provide for the scenario in which resolution powers under the Financial Institutions (Resolution) Ordinance (FIRO) are exercised by the Monetary Authority as the Resolution Authority.
The HKMA has also taken the opportunity to communicate and restate the framework for provision of liquidity, incorporating certain refinements to the prior arrangements where appropriate, so as to foster a better understanding on the part of the market of the different facilities through which the HKMA makes temporary HKD liquidity (i.e. not in the nature of capital support) available to AIs to maintain integrity and stability of the monetary and financial systems in Hong Kong.

The latest escalation in US-China trade tensions has already put additional depreciation pressure on RMB FX. It is increasingly likely that our target 7.5000 will be reached as soon as autumn.
If China were to offset the announced additional tariffs by the US via RMB depreciation only, we suspect USD/CNH would need to reach as high as 7.65. So far, we have merely based our analysis on what degree of RMB depreciation is needed in order to compensate for the potential loss of trade competitiveness as a result of tariffs.

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